Question

On January 1, 2018, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2019.

Expenditures on the project were as follows:

January 1, 2018	$	1,260,000
March 1, 2018		750,000
June 30, 2018		310,000
October 1, 2018		680,000
January 31, 2019		1,035,000
April 30, 2019		1,350,000
August 31, 2019		2,430,000

On January 1, 2018, the company obtained a $3 million construction loan with a 11% interest rate. The loan was outstanding all of 2018 and 2019. The company’s other interest-bearing debt included two long-term notes of $5,700,000 and $7,700,000 with interest rates of 5% and 7%, respectively. Both notes were outstanding during all of 2018 and 2019. Interest is paid annually on all debt. The company’s fiscal year-end is December 31.

Required:
1. Calculate the amount of interest that Mason should capitalize in 2018 and 2019 using the weighted-average method.
2. What is the total cost of the building?
3. Calculate the amount of interest expense that will appear in the 2018 and 2019 income statements.

Answer 1

Requirement 1

2018:

          Expenditures for 2018:

          January 1, 2018               $1,260,000 x 12/12 =   $1,260,000

          March    1, 2018                    750,000 x 10/12 =         625,000

          June      30, 2018                    310,000 x    6/12 =         155,000

          October   1, 2018                    680,000 x    3/12 =         170,000

          Accumulated expenditures

             (before interest) -             $3,000,000

          Average accumulated expenditures -                            $2,210,000

          Interest capitalized:

          $2,210,000 x 7.04% = $155,584 = Interest capitalized in 2018

* Weighted-average rate of all debt:

      $ 3,000,000 x 11% = $   330,000                $1,154,000

        5,700,000 x   5% =       285,000                                  = 7.04% (rounded)

          7,700,000 x   7% =     539,000               $16,400,000

      $16,400,000                  $1,154,000

2019:

          January   1, 2019

          ($3,000,000 + 155,584)            $3,155,584 x   9/9 =      $3,155,584

          January 31, 2019                 1,035,000 x   8/9 =            920,000

          April   30, 2019                 1,350,000 x   5/9 =            750,000

          August 31, 2019                 2,430,000 x   1/9 =            270,000

          Accumulated expenditures

             (before interest) -             $7,970,584

          Average accumulated expenditures -                            $5,095,584

          Interest capitalized:

          $5,095,584 x 7.04% x 9/12 = $269,047 = Interest capitalized in 2019

         

Requirement 2

          Accumulated expenditures 9/30/19

          before interest capitalization (above)             $7,970,584

          2019 interest capitalized (above)                          269,047

          Total cost of building                                 $8,239,631

Requirement 3

2018

       $3,000,000 x 11% =                                    $   330,000

         5,700,000 x    5% =                                         285,000

         7,700,000 x    7% =                                         539,000

            Total interest incurred                                   1,154,000

            Less: Interest capitalized                                 (155,584)

               2018 interest expense                              $   998,416

2019

            Total interest incurred                                 $1,154,000

            Less: Interest capitalized                                 (269,047)

               2019 interest expense                              $   884,953